DOMESTIC FINANCING MEXICO UPDATED TO JANUARY 1988

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP98-01394R000200010001-6
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 31
• Document Creation Date: December 27, 2016
• Document Release Date: July 30, 2013
• Sequence Number: 1
• Publication Date: January 1, 1988
• Content Type: REPORT

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III?Domestic Financing
'Co
UPDATED TO JANUARY 1988
1.0 Introduction
1,1 Political assessment. Mexico continues to enjoy a
high measure of political stability. The Institutional Revolu-
tionary Party (PRI), which has been in office for the last 58 years,
maintains a firm grip on political power despite growing discon-
tent over the country's prolonged austerity program. Declining
consumer purchasing power and a stagnant economy are likely
to cost PRI presidential candidate Carlos Salinas de Gonad a cer-
tain amount of popular support in the July 1988 elections, but
this will be expressed mainly in absenteeism, since there is no
serious threat from the opposition parties. It is a foregone con-
clusion that Carlos Salinas de Gortari will win the 1988 presiden-
tial election and that the PRI will retain control of the legislature
and all governorships.
Opposition parties, especially the conservative National Ac-
tion Party (PAN), have had some limited success in winning elec-
toral victories in the north owing to the growing disenchantment
of the middle class, whose fortunes fell drastically when the
boom years ended. Discontent among the middle class has also
given rise to independent grass roots organizations in the
ecology movement and in the reconstruction efforts following
the September 1985 earthquakes. Independent leftist unions
have also been gaining influence on the periphery of the official
labor sector and represent the only left-wing force with any
power base.
However, leftist parties still lack the unity necessary to present
a serious challenge to the PRI. Political infighting prevented the
left from unifying behind PRI dissident Cuahtemoc Cardenas,
the son of Lazar? Cardenas, the most popular Mexican president
in this century, when he left the PRI to become an opposition
presidential candidate.
With the growing uncertainty following the Mexican Stock Ex-
change's crash, the primary goal of the outgoing administration
of Miguel de la Madrid is to restore confidence so as to allow for
the election of Mr. Salinas in an atmosphere of relative calm.
To achieve this, the administration needs to regain control
over inflation, which has gone unchecked for the past two years.
But despite recent efforts, especially the Pact of Economic
Solidarity, which included a 21.9% currency devaluation along
with an 85% price increase in many public goods and services
Important Financial Events
?Government promises wage indexation in
March (1.1)
?Government launches fight against high
inflation (1.1)
?Mexico launches debt restructuring scheme
to reduce debt servicing burden (1.2)
?The world's fastest growing stock market
becomes the world's fastest falling (8.1)
oTax reform package knocks tax incentive
scheme (9.3)
and a reduced budget in 1988, it seems unlikely that the govern-
ment will succeed. The budget needs to be drastically cut?a tall
order in an election year on account of the implied lower growth
and higher unemployment.
The public has already suffered through prolonged recession
since 1982; labor accepted a 38% accumulated wage increase in
late 1987 (well below inflation) in return for the administration's
promise to index wages on a monthly basis in March 1988.
1.2 Economic environment. Mexico is struggling to restore
confidence following the Mexican Stock Market crash. The
government has raised interest rates and devalued the free
market exchange rate to stem capital flight, returning to the tight
credit and high interest rate policies that averted a major
economic crisis in 1986 and early 1987.
These measures, however, will push up inflation?which
could reach as high as 200% by the end of 1988?and unemploy-
ment levels while putting a brake on already sluggish growth.
GDP growth for 1987 was only 1%, while the budget deficit hit
18.5% of GDP, with inflation at 158.9%.
The de la Madrid administration will complete its term with
one of the lowest average GDP growth rates in modern Mexican
history, at a time of massive growth in the labor market. As a
In the process of updating this chapter of FFO, some financial conditions may have changed. For the most current interest and foreign
exchange rates, please refer to the FFO Interest Rate & Forex Updaters, which are sent once a month to subscribers.
FFO MEXICO 0 January 1988 Business International Corp 1
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Mexico Data Bank
1987
1988
1989
GDP (% real growth)
1.0
3.9
2.0
Current account (US$ billions)
2.35
-2.25
-2.55
Trade account (US$ billions)
7.4
5.6
5.3
Inflation (% change)
127.0
165.0
120.0
Exchange rate (P:$1, year-end)
controlled
2,193
5,600
8,100
free
2,250
5,700
8,300
Prime rate (%)
190.0
230.0
120.0
result, the pressure for stimulative policies will be intense and
growth will continue to be a priority concern of the next ad-
ministration. Foreign creditor nations should take heed of Mex-
ico's contention that it must be allowed to grow in order to pay
its debt service.
Mexico's new debt restructuring scheme will reduce the
burden of its foreign debt payments. Under the new scheme,
Mexico will trade 20-year dollar-denominated bonds effectively
backed by the US government for Mexican debt with creditor
banks. The Mexican bonds will pay interest of LIBOR plus 1.625
points on a semiannual basis and will be backed by $20 billion
dollars worth of 20-year "zero coupon" US bonds that the Mex-
ican government will purchase at 10% of their face value.
Mexico's savings on interest payments will depend upon how
much creditor banks discount Mexican debt when trading it in
for the new Mexican bonds. Banks are expected to trade the
debt at between $0.60 and $0.70 of its face value, which would
save Mexico some $18 billion in interest payments over the next
20 years, or about $900 million annually. This combined with
$12 billion dollars in new money over 1987 and 1988 should
provide a window for balance-of-payments stability through the
1988 presidential election period.
While Mexico has approximately $11 billion in foreign
reserves, major external downside risks in 1988 include a con-
tinued fall of oil prices and a possible rise in US interest rates.
The delay in receiving credits from abroad?some $3 billion
was originally to have been disbursed in 1986?dampened
economic growth in 1987 and made it impossible for the govern-
ment to reduce significantly its domestic borrowing require-
ment, which reached 18.5% of the country's approximately
P190 trillion GDP at end-1987. Soaring interest rates have made
the domestic debt service an obstacle to revival of the economy,
and fears that increased government spending would stimulate
hyperinflation have forced the Mexican cabinet to reconsider its
highly inflationary budget for 1988.
The government is scheduled to cut the 1988 budget from
P235 trillion to P208 trillion, thus reducing the government
deficit by 1.5% to 170/0 of GDP, but this will allow for little or no
economic growth. Moreover, since these cuts will not be
enough to offset the inflationary pressure of the March wage in-
dexation, inflation will remain in the three-digit range through
the end of 1988.
The crucial period for balance-of-payments sensitivity will be
2 FFO MEXICO @ Jar ,jr 1988 Btisinoris International Corp
between April 1988, when the agreement with foreign creditors
expires, and December 1988, when the new president takes of-
fice. Capital flight will increase during this period as part of the
historic election year cycle.
1.3 Financial conditions. Liquidity has been tight since Ju-
ly 1985, when Banco de Mexico (the central bank) significantly
tightened restrictions on the amount of new bank funds
available for lending to the private sector. The move was
originally billed as a temporary three-month measure, but is still
in force. While the arrival of new credits in mid-1987 brought
temporary increased liquidity, this quickly disappeared follow-
ing the Mexican Stock Market crash.
When mandatory reserves and specially earmarked funds are
taken into account, some 90% of all bank resources are con-
trolled by the government. Through the first 11 months of 1987,
financing to the private sector totaled approximately P21
trillion-10% of GDP, roughly the same level as in 1986.
Inflationary expectations will strongly affect the government's
ability to provide more credit to the private sector in 1988. The
$13 billion in foreign reserves at end-1987 will allow the govern-
ment to service its international obligations, but soaring
domestic interest rates based on inflationary expectations are
making the internal debt increasingly difficult to service. Despite
the increased revenues expected from Mexico's 1987 income
tax reform, any credit opening will hinge on the government's
ability to restrain interest rates.
The average cost of funds has struggled to keep pace with in-
flation, with prime rates rising from 90.30% in October 1987 to
104.29% in December. Moreover, credit availability is very low.
The de la Madrid administration's attempt to reduce interest
rates in the first week of December was thwarted when investors
opted to sell almost P4 trillion in government Treasury bonds,
known as Cetes, rather than accept interest rates of 114% for
28-day bonds and 123% for 91-day bonds. The following week
the government was forced to issue Cetes at rates of 120.30?/0 for
28-day bonds and 129.99% for 91-day bonds?rates 20 points
higher than those offered in the second week of November.
Subsequently, the government issued P2 trillion in short-term
Cetes in the last week of December 1987 at rates of 120.70% for
eight-day bonds and 121.64% for 15-day bonds to try to slow the
growth of interest rates. This action was coupled with a forced
85-day loan by domestic banks to the central bank of P100
billion to reduce market liquidity. The government has managed
to keep real returns on these investments positive, but infla-
tionary expectations and tight monetary policy are exerting con-
siderable upward pressure on interest rates.
Real borrowing costs will remain in the 180% range for bank
loans to prime customers, with poor credit availability continu-
ing throughout the first half oil988. For this reason, the extrabur-
sati I (parallel) market will continue to be a mainstay for rapid
short-term borrowing.
1.4. Discrimination against foreigners. With , limited
credit availability, it has become increasingly difficult for foreign
companies to borrow locally, even within the commercial
banks' guidelines. However, the larger banks generally make an
effort to provide credits to their most valued customers, many of
which are multinational companies. Typically, banks restrict the
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amount of funds an MNC can obtain, but continue to offer low,
even below market rates.
Access to special funds available through government agen-
cies can be difficult for majority foreign-owned firms, but the full
deductibility of these loans under the new tax system will make
the effort increasingly worthwhile as the new tax system
becomes fully operational. Fomex continues to provide preex-
port and export credits to majority foreign owned-firms based on
local content levels. Interest charges climbed in early 1987 as a
result of moves to eliminate trade subsidies prohibited by GATT
and the US agreement on countervailing duties. Fomex is also
less willing to grant foreign-majority companies peso preexport
credit.
MNCs with easily identifiable alternative sources of financing
may have trouble obtaining approvals for loans from these
funds, but export-oriented projects and those involving reloca-
tions to a priority zone stand a better chance. A 50/50-owned
foreign firm recently won Foreign Investment Commission (FIC)
approval to be considered Mexicanized for purposes of receiv-
ing Fonei equipment financing. In general, the government
prefers that majority foreign-owned firms bring in capital and not
rely on the shallow local financial market.
The situation eased in early 1987, however, when the Na-
tional Securities Commission (CNV) allowed foreign-owned
firms to resume issuing variable rate bonds (obligaciones) follow-
ing a freeze in 1986?but the high rates on such issues at the mo-
ment (144-146% p.a.) make them relatively unattractive.
Nearly all types of local borrowing, by either local or foreign
firms, require guarantees, but since November 1985, foreign
representative banks have been forbidden to directly guarantee
peso loans. Indirectly many have continued to do so, however,
using local banks as intermediaries or through the use of offshore
credit lines and insurance schemes. A number of casas de bolsa
(brokerage houses) also continue to accept direct foreign letters
of credit, listing them as unguaranteed loans in reports to the
CNV, as there has been no real enforcement of the restriction.
The 1983 banking law prevents foreigners from acquiring
equity in financial institutions in Mexico. The only foreign and
privately owned bank operating in Mexico is Citibank, which
was established before restrictive legislation went into effect in
1966. Citibank was also exempted from the 1982 nationalization
decree, but has not been allowed to expand its branch network.
Also in 1982, Mexico published the rules under which foreign
financial institutions may open offshore banking offices in the
country?rules offering no tax breaks or access to the domestic
market. It is therefore not surprising that no offshore branches
have yet been established.
The chief form of discrimination against foreign lending to
Mexico has been a 15% withholding tax that non-Mexican banks
must pay on gross-interest receipts from Mexican sources. The
tax is a highly contentious issue, and Mexico's treasury secretary
has promised to abolish it. Five years ago most banks absorbed
the it, but few do so now because they are not able to apply
foreign tax credits against foreign income, which has dropped
substantially over the last several years. Virtually all restructuring
contracts stipulate that the client must absorb the 150/. tax. Lend-
ing institutions of foreign governments, including banks with
state participation, also pay a withholding tax of 15%, and in-
terest on loans from nonregistered financial institutions (e.g.
parent company loans) is taxed at 42%. As a result, most parent
company loans are routed through banks in the form of back-to-
backs.
A 21% withholding tax applies to interest on loans from
foreign suppliers of machinery and equipment for industries "of
public interest." The same rate is charged on loans from non-
financial institutions (i.e. parent companies) if the loan is in the
public interest. Otherwise, the rate is 42%?which tends to
discourage intercorporate lending. Mexico can view interest
payments on such loans as dividends, subject to a prior payment
of a 10% on pretax profits, a 42% corporate income tax and a
50% dividend tax if they are deemed concealed dividends.
1.5 Corporate financial strategies. The return to credit
scarcity following the temporary liquidity in mid-1987 is forcing
international companies to fall back on the wide range of bor-
rowing sources developed during the 1986 credit squeeze,
when companies diversified sources and built new relationships
with both lenders and brokers. Perhaps the most important
financial strategy, however?given the cost of money and con-
tinued high foreign exchange risks?was a reduction of the need
to borrow by an improvement of cash management.
For many companies, tighter management of receivables and
payables is the key to improved liquidity. Chronic slow payment
by government offices and state firms in recent years has resulted
in many companies' putting a percentage cap on sales to the
public sector whenever possible. Banks discount receivables of
chronic late payers such Pemex and Conasupo and then redis-
count them with the Fogain industrial development fund, but
up-front discounts can run over 100%, currently making such
financing unrealistic.
Companies that are able to borrow from cash-rich sister sub-
sidiaries will be able to weather the credit crunch particularly
well. In most cases, such peso pooling arrangements represent
about the cheapest form of financing available. Also, deals can
be executed rather quickly with proper coordination among the
companies involved.
The sharp downturn in the supply of bank funds available for
lending has limited the ability to draw down large amounts of
bank financing quickly, although the large banks have tried to
help prime customers with small amounts of exceedingly cheap
credit.
Competition from the parallel market?chiefly from casas de
bolsa ?is leading to a gradual elimination of compensating
balance requirements and interest up-front-payments for prime
customers. Such charges were often unavoidable in the past, but
now the large Mexican banks are often willing to forego
them?though the small banks still tend to demand them.
Companies continue to view the parallel or ext rabursatil finan-
cial market as a permanent second source of short-term financ-
ing. The parallel market offers the advantages of speed and
creativity for foreign companies with good credit ratings. MNCs
continue to closely cultivate their banking relationships,
however, and bank credit, when available, remains cheaper. In
1987, the extrabursatil market accounted for approximately 50%
of total domestic market resources.
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In some cases, parallel market operations consist of straightfor-
ward deals between corporate treasurers. This helps to save on
brokerage fees, which can run between 1% and 3% depending
on the amount being borrowed. More frequently, brokers are in-
volved in matching lenders with borrowers.
While nominal rates may appear reasonable, the real cost of
borrowing on the parallel market can be quite high when
brokerage costs, higher fee structures and guarantees are all fac-
tored in. First-time participants in the market often have to put
up a foreign letter of credit backed by a parent guarantee. Some
prime firms have been able to get casas de bolsa to accept
straight parent guarantees, however, thereby cutting the cost.
Most MNCs in Mexico tend to stay away from the bolsa (stock
market) as a source of capital, since issuance of commercial
paper has become exceedingly expensive because of the need
to keep pace with ever-rising Cetes rates. Also, many firms are
discouraged from issuing paper by the extensive disclosure re-
quirements. Rates paid on ext rabursatil paper are only a point or
two higher than what would be paid on regular bolsa-issued
commercial paper, and the transactions can be executed much
nore rapidly. In the last year, the extrabursatil commercial paper
market grew from P82.2 billion in December 1986 to P466.4
billion in December 1987.
Long-term capital is practically nonexistent, but some MNCs
launched bond issues in 1987 following the lifting of restrictions
on this type of operation imposed a year earlier by the CNV
(7.3). However, the authorities still consider that foreign firms
should bring in their own funds and leave local resources for
local firms.
The credit crunch will force some foreign firms to obtain
parent company funding, although there is no evidence that this
has taken place on a widespread basis. Most companies have in
fact tried to wipe out their parent company loans, even when
doing so meant borrowing heavily in the local market at ex-
tremely high rates. As Mexico's new tax system is phased
in?penalizing heavy indebtedness?companies may have to
utilize retained earnings and equity investment to substitute for
heavy peso borrowing. Such borrowing will still be advan-
tageous from a tax standpoint in, 1988, however, since com-
panies will be operating 60% on the old tax system.
Uncertainty will continue to mark borrowing conditions.
Nevertheless, new instruments and options will emerge to meet
the demands of the marketplace. The parallel market is certain
to expand, although the government will increasingly try to con-
trol it. Fideicomiso para la Cobertura de Riesgos Cambiaros
(Ficorca?Mexico's private debt coverage scheme) sales should
be an important technique for financial restructuring and expan-
sion in 1988. By the first quarter of 1988, companies should be
able to tap into the foreign bank peso onlending program ex-
pected to be initiated by the government. A private debt swap
program using these peso onlending funds is also expected to
emerge eventually.
Changes in the regulations governing venture capital funds
have sparked interest from several foreign banks in investing in
the operating companies of the funds. This has the potential to
strengthen the traditionally shallow local market and provide a
source of investment capital for companies in the future.
4 FFO MEXICO ? January 1988 Business International Corp
2M Currency Considerations
- -
2.1 General. Mexico haS--a twoztieixt-hange posed
-
posed of a_contr011ed and a free rate. The former is used to con-
vert all exports, imports, public and private foreign-debt
payments (except for debts registered under the Ficorca pro-
gram's preferential rate), royalty payments, in-bond expenses,
and foreign currency payments incurred before Dec. 20, 1982,
and payable within Mexico. The free rate applies to all other
foreign exchange operations and is market-sensitive but not im-
mune to central bank intervention. The dual exchange rate
system is Mexico's most effective exchange control, and as long
as the risk of capital flight looms the two-tier system will be main-
tained.
The controlled rate accounts for about 75% of all foreign ex-
change transactions. When the two rates are close, many com-
panies circumvent the government through free market opera-
tions. Free market transactions provide rapid access to funds and
allow exporters to avoid the obligation to return the funds to
Mexico within 90 days. The controlled rate will be maintained,
however, and the spread between it and the free rate is sensitive
to capital flight, as was demonstrated in the aftermath of the
Mexican Stock Market crash.
In 1985, the system of regular daily minidevaluations was
replaced by one in which peso slippage takes place via a "ra-
tional float," that is, on an unscheduled but fairly predictable
basis. In setting the rate, Banco de Mexico takes into considera-
tion balance-of-payments factors and short-term supply-and-
demand trends reported by banks. The official controlled rate for
a given day is formally known as the tipo de cambio de equilibrio
and is determined at daily meetings between Banco de Mexico
and commercial banks. Since fail 1986, the rate announced in
the Diario Official each day has been the rate for the following
day. The system has given the foreign exchange system an im-
portant measure of stability, since the pace of slippage generally
does not change much from day to day. Most important, the
system allows the government to keep the peso realistically
valued.
There are now two free rates: the official government free rate
and the exchange-house rate. The difference between the two is
currently less than 1%. At the end of 1987, the official free stood
at P2,260.8:$1, vs P2,278:$1 for the average exchange-house
rate.
During the first ten months of 1987?until the stock market
crash?de facto government policy was to keep the differential
between the controlled and free exchange rates small-2% or
lower?with Banco de Mexico selling dollars on the exchange
market to narrow the differential and to maintain stability and
confidence. The action was effective primarily because of tight
credit conditions and depressed demand for foreign exchange.
This slight difference between the rates prevailed despite a
slowdown of the controlled devaluation rate as a measure to
combat inflation. The measure did not succeed in slowing infla-
tion and as a result contributed to the peso's becoming less
undervalued.
In the midst of growing pressure for more rapid devaluation,
the Mexican Stock Market crashed, and Banco de Mexico not
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only had to make up for lost ground but also had to stem growing
capital flight. The central bank proceeded to make a series of
moves to control the situation.
First, it moved to stop capital flight by withdrawing from the
free market on November 18, causing a 41% devaluation?the
free market dollar rose from P1,714.9 to P2,433. This relieved
capital flight pressure on the free market dollar, and the gap be-
tween the free market and controlled rates narrowed from the
42% registered after the crash to 25% by mid-December.
Banco de Mexico's next move was to speed up the controlled
rate devaluation against the dollar from P2 per day to P3 per day.
However, this did not prevent the controlled exchange rate from
falling behind inflation, since interest rates also had to be raised
nearly 30% to keep capital from fleeing the country.
Finally, on Dec. 14, the government devalued the controlled
rate by 22% reducing the gap between the controlled and free
rates to 3.6%. Since the controlled rate devaluation, the gap be-
tween the two rates has stayed below 2%, primarily because the
central bank is supporting the free market rate.
2.2 Currency behavior and forecast. Despite $13 billion
in foreign reserves as of end-1987, the peso will continue to
weaken because of lack of confidence, and Mexico appears to
be headed toward balance-of-payment problems. On the inter-
national front, falling oil prices and a possible hike in the US
prime rate are two major factors that could force Mexico back to
the bargaining table with its international creditors.
Mexico remains heavily dependent on oil exports, so that a
continued downward trend in oil prices would place a great
strain on foreign reserves. Meanwhile, since some 56% of the
P208 trillion government budget has been set aside to service
the foreign and domestic debt, a rise in international interest
rates would strain government finances considerably. The $900
million annual savings generated from Mexico's new debt
restructuring scheme will relieve some of the pressure of foreign
debt servicing, but how long it takes to get on line and the
amount that creditor banks discount the Mexican debt will
determine just how much relief this measure will provide.
The de la Madrid administration's recently announced Pact of
Economic Solidarity to combat inflation is being viewed with
skepticism. The policy requires a temporary freezing of the con-
trolled rate to check the inflationary pressures of gradual
devaluation, but attempts to slow the devaluation rate in early
1987 were unsuccessful in containing inflation. Nevertheless,
the controlled rate peso is likely to remain frozen at its end-1987
level of P2,204:$1 until at least mid-March 1988, when a
devaluation of up to 15% is expected to bring the controlled rate
more in line with the free rate.
As of mid-January 1988, the free rate was P2,260:$1, shored
up by central bank intervention. The anticipated devaluation is
likely to precede the introduction of the new inflation index in-
tended as the trigger mechanism for the wage indexation prom-
ised in the 1987 labor negotiations.
Controlled rate and free rate parities are expected to be
P5,000:$1 and P5,100:$1 respectively by the end of 1988.
2.3 How the spot market works. While use of the free
market has been high on account of the de facto unification of
the two rates, some 75% of all foreign exchange transactions are
still carried out at the controlled rate, with the balance con-
ducted at the free rate. The government is the only seller in the
market for controlled-rate dollars. All applications for con-
trolled-rate dollars must be made through the firm's commercial
bank; the bank then turns over the application to Banco de Mex-
ico, which processes the forms and releases the dollars. Dollar
availability was good throughout 1987; if a crunch is to come, it
should hit before the end of the first half of 1988.
Commercial banks and exchange houses deal in free-rate
dollars. Although rules have been in force recently that have
limited the amounts of dollar purchases per transaction ($10,000
for companies; $500 for individuals), these limits have not been
consistently enforced.
2.4 Taxation of forex gains and losses. When the new
tax system is completely operational in 1991 (it is being phased
in over four years), deduction of foreign exchange losses will be
limited to the real component. Under the law, exchange losses
are treated as interest and firms can generate "an inflationary
profit," which can increase monthly tax payments. The new tax
law is expected to bring about a change in the current corporate
strategy of maximizing exchange losses.
In 1988, existing strategies will still be advantageous because
firms will be operating 60% on the old tax system. Foreign ex-
change losses are fully deductible under the old system but only
deductible in real terms under the new system. The loss is
calculated by using the difference between the exchange rate in
effect when the foreign currency liability was incurred and the
rate in effect when payments are due.
In 1983, officials ruled that if companies renegotiated their
foreign credits on longer terms, they could take the full deduc-
tion for exchange losses at the controlled rate in force on Dec.
31, 1983 (P96:$1), even if they were unable to make the
payments. The deduction for exchange losses can still be taken
when a payment is due, even though it is not actually made. The
debtor no longer has to assume the exchange loss. Additional
losses suffered when payment is made may also be deducted;
they are calculated as the difference between the exchange rate
at the due date and the rate at which payment is made. If a com-
pany has to purchase foreign currency at the free market rate to
comply with its obligations, it may deduct the difference be-
tween the controlled and free rates set at Banco de Mexico on
the day of operation. Companies cannot deduct the difference
between Banco de Mexico's free rate and a higher rate at which
they might have purchased foreign currency.
There are three alternatives for tax deduction of exchange
losses on debt enrolled in the private debt coverage scheme
known as Ficorca. The deduction can be taken (1) in one sum
during the year the loss is suffered; (2) in, equal shares over four
years, beginning when payment would have been due under the
original loan terms; or (3) when payment is actually made under
the program. Foreign exchange gains are taxable in the fiscal
year when the claim or the debt becomes due according to the
original terms of the debt. Any additional exchange gains be-
tween the due date and payment date are taxable in the fiscal
year payment is made.
Firms must include bank and supplier debts, foreign exchange
credits, cash, and accounts receivable and payable in their
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obligatory foreign exchange disclosure statement (register). This
register, 'which must be certified by the secretariat of the
treasury, will enable officials to monitor exchange gains and
losses.
2.5 Forward contracts and other hedging techniques.
Mexico has moved to provide several types of forward protec-
tion to replace the loss of such coverage with the shutdown of
the offshore forward market in late 1985. It has made legal dollar
accounts for firms operating within 20 kms of the border. In 1986
it also launched a dollar indexed treasury bond called the Pagafe
(Pagare de la Tesoria de la Federacion). Pagafes are sold in pesos
and bought in pesos at the controlled rate but valued in $1,000
dollar denominations. There has been little enthusiasm for the
bonds despite rates as high as 15%.
In January 1987, Mexico launched a forward market which is
also a controlled peso mechanism, with coverage available up to
six months out. However, the high interest rates and steep
premiums charged by participating banks have caused corpora-
tions to shy away from the mechanism. Some corporate
treasurers also report they sometimes have trouble getting
home-office approval to use peso mechanisms as hedges since
the practice does not guarantee access to dollars. Participation
in the instruments could increase in 1988, however, if peso
volatility increases as expected.
A traditional peso hedge has been petrobonds, which have a
strong secondary market. While the change from quarterly to
monthly interest payments and the pegging of interest to Libor
plus four made the first 1987 issue more attractive, the fact that
the second 1987 issue is not backed by a guaranteed price per
barrel of oil has made this instrument more risky.
Mexican government officials do not want to see a return to
offshore peso trading because of the pressure it places on the
currency. However, Citibank has created an informal forward
market to help companies protect against devaluation. The
scheme works in the following manner:
? Day 1. Company A invests some P2.276 billion in Citibank
at a set interest rate for 30 days. Citibank takes the money and
changes it into $1 million (P2,276:$1) and invests it for 30 days.
Meanwhile, Citibank locates company B, which is interested
in purchasing dollars at a fixed exchange rate in 30 days.
? Day 30. Citibank takes the $1 million plus the interest
earned over the 30-day period, say $100,000, and buys pesos at
the guaranteed rate from Company B. Citibank then uses these
pesos to pay Company A its principal investment plus interest.
Firms in Mexico also enjoy a hedgelike option when they pur-
chase controlled-rate dollars. Since mid-1985 (when Banco de
Mexico established a new policy for setting the controlled ex-
change rate?the "rational float" system?see 2.1), firms have
had two choices for purchasing controlled rate dollars: a "firm"
operation or a "conditional" one. Under the former, the com-
pany agrees to buy or sell dollars at the rate in effect on a
specified date. The latter allows the firm to set a limit within a
certain time period and to trade only if the peso reaches that
limit. The minimum for conditional operations is $50,000.
Applications for controlled dollars at the equilibrium rate (the
official posted rate) must be made at least two days before the
daily session that sets the rate for firm transactions or marks the
6 FFO MEXICO ? January 1988 Business International Corp
beginning of the option period. For a firm operation, the transac-
tion must take place within two days after the session. If an im-
porter has to pay for a shipment in one week, there will not be
time to arrange a conditional operation. If, however, it can an-
ticipate dollar needs?and has quick access to cash?the im-
porter might find it worthwhile to speculate by using the condi-
tional arrangement. The transaction must be carried out within
two days of the session in which the specified exchange rate was
reached.
Companies that need to buy or sell dollars in less than a week
may trade directly with the banks at what is known as the tipo de
cambio de ventanilla; they may have to pay a bit more for their
hurry, but they take no risk. The bank sets this rate to cover
possible fluctuations in the equilibrium rate; the margin be-
tween buying and selling can be wide.
Another hedgelike option is prepayment of imports, for which
controlled-rate dollars are available. In March 1986, officials
sweetened this option by ruling that exporters and their affiliates
could use up to 100% of their export earnings to prepay imports.
This tends to reduce a firm's liquidity, however, and government
authorities introduced the forward market in part to allow ex-
porters to cover the exchange rate risk of tapping low-cost ex-
port bank credits available from many nations.
Mexico has two commodity-based investment instruments,
petrobonds and silver bonds. Petrobonds are dollar-linked,
payable in controlled-rate pesos, but the second 1987 issue has
eliminated the fixed percentage of Isthmus crude at a guaran-
teed minimum price. Silver bonds (Ceplatas) are issued in
100-troy-ounce denominations and are dollar-linked, payable in
controlled-rate pesos, but have no guaranteed price.
3.0 Foreign Exchange Regulations
3.1- Gener?a1.-Since the relaxation of exchang-e?c-cmt-rol-af
the -end of 1982,- -there have no longer been any restrictions ,
"(other than currency availa-bility)-Cirf the remittance of iiiterest-,.
diVidends or capital abroad by either nationals or foreigners.
The de la Madrid administration (especially Banco de Mexico
head Miguel Mancera) has consistently opposed formal ex-
change controls. In fact, officials have eased access to hard cur-
rency, especially for exporters and their affiliates. Bureaucratic
footdragging is not as prevalent as it was in the past, and this
general policy trend is likely to continue as long as Mancera
heads the central bank, but it could be altered if at some point
balance-of-payments conditions once again grow acute.
While there is a theoretical limit of $10,000 per transaction on
free market purchases by companies, the cap had not been en-
forced until the final day of trading of 1987. Banco de Mexico
had to enforce the cap then because of excess demand for
controlled-rate dollars. Theoretically, large foreign exchange
transactions must be reported before they are executed. Regula-
tions governing technology-transfer payments empower a
government agency to reject licensing contracts if it deems the
royalty payments excessive. Royalty payments are set on a case-
by-case basis, and no single limit applies. Officials have tradi-
tionally cited 3% sales as the medium, but they have recently
been reported to go as high as 10% if the technology contributes
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to development and especially to export goals.
rasclim-bre-reqvirernents. Since January T9Z-Z1,_cories)
115av-e-beeTh required to keep a certified register of all their foreign)
LCurrency transactions. These include-Fa-ilk supplier--debrs,)
(r_Clieign exchange credits, accounts receivable.and_payable?andp
casIri oifionc)Incorrect invoicing (e.g. underinvoicing of ex-
ports and overinvoicing of imports) and other violations of
foreign exchange regulations are heavily penalized, and
violators may be kept from exporting or purchasing foreign cur-
rency for import purposes if such infractions occur.
3.2 Incoming direct investment. Majority Mexican con-
trol of equity and management is required for companies
operating in Mexico, and foreign investment must complement,
rather than displace, local investment and contribute to
development goals. In most industries, foreigners may hold up
to 49% of the capital of new ventures.
The secondary segments of the petrochemical and auto parts
industries come under separate legislation, which decrees a
minimum of 60% Mexican ownership. (Officials are reportedly
in the process of drafting legislation to allow majority foreign
capital in these sectors.) In the mining sector, there is a strict
maximum of 40% foreign equity, except in the case of special
mineral concessions, for which the foreign maximum is 34?/0.
The provisions of the foreign investment law do not apply to the
in-bond 'industry (maquiladora?light-assembly operations that
are given tax and other benefits), in which facilities may be 100%
foreign-owned.
Majority foreign-owned companieS already operating in Mex-
ico when the foreign investment law was passed in 1973 must
obtain Foreign Investment Commission (FIC) approval for
foreign participation above 25% of total equity, expansions, in-
troduction of new product lines and other changes in their
operations. In the past, approaching the FIC often triggered a de-
mand that the company Mexicanize. Now a slightly different at-
titude prevails.
Ira company is operating in a priority industrial sector, such as
consumer basics, capital goods or heavy industry, and is
prepared to increase exports, increase the use of local inputs,
decentralize or create jobs, the government frequently permits
expansion without Mexicanization. Foreign investment officials
maintain they approved 90% of requests for increases in foreign-
owned capital from minority to foreign majority ownership dur-
ing 1987. For the remainder of the de la Madrid administration,
Mexicanization will be a low priority with the FIC.
Two resolutions were introduced in Sept. 2, 1986, to make in-
vestment easier. Resolution 14 declares investment by multila-
teral organizations and government development banks to be
neutral for purposes of the foreign investment law. Resolution 15
streamlines investment procedures for small and medium-sized
businesses seeking to invest in Mexico. Such firms, defined as
companies whose parent has no more than 500 employees and
no more than $8 million in sales, can make majority in-
vestments, relocate establishments or engage in new lines of ac-
tivity within Mexico without prior FIC approval. Each Mexican-
based subsidiary of such small firms must operate in manufactur-
ing, employ no more than 250 people and have net annual sales
of no more than the indexed equivalent of P1.1 billion. The size
restrictions on the parent company have come under fire as be-
ing too restrictive to attract much foreign investment, and there
is some speculation that they might be liberalized.
These reforms should not be viewed as backtracking on the
foreign investment law; selectivity will remain the basic theme of
foreign investment policy, with emphasis shifting within the
framework of the law as government priorities change. If suffi-
cient development benefits can be' obtained, Mexican officials
see them as more in the national interest than a forced 51/49
equity split.
3.3 Portfolio investment. No particular rules deal with a
foreign acquisition of an interest in a local, publicly held enter-
prise. However, the 1973 foreign investment law holds that
foreign companies must obtain authorization from the govern-
ment before acquiring more than 25% of the equity or more than
49% of the fixed assets in established ventures. FIC authorization
is necessary for the acquisition of any number of shares of a com-
pany when such a purchase results in the total foreign invest-
ment's exceeding 25% (or if 25% or more of the capital stock of
the company is already foreign-owned).
The 1983 banking law prevents foreigners from acquiring
equity in financial institutions in Mexico. The only foreign and
privately owned bank is Citibank, which was established before
restrictive legislation went into effect in 1966 and which was ex-
empted from the September 1982 nationalization decree.
Minority foreign participation is allowed in brokerage houses,
which have become among the most creative and fastest-
growing forces in the financial market. Foreign ownership of
venture capital and stock mutual fund operating companies has
also been made easier.
In early 1987, new government regulations allowed mutual
fund operators to own more than 49% of the companies in
which they invest. Furthermore, mutual fund operators do not
have to pay tax on profits until the profits are distributed as
dividends. While the Mutual Funds Law includes a 10% foreign-
participation limitation, it also allows for exceptions where proj-
ects are deemed particularly beneficial to the economy. In prac-
tice, the authorities want to negotiate deals individually, and
they have indicated a willingness to grant foreign ownership
levels substantially above 10%. With special FIC and Treasury
Secretariat approval, a foreign investor can theoretically own a
majority stake in such an operating company.
Foreigners cannot hold Cetes treasury certificates directly but
can invest in a bolsa fund that includes Cetes, or in a similar bank
fund. Typically, a treasurer will invest through a casa de bolsa or
a bank fund consisting of Cetes, commercial paper, banker's ac-
ceptances and perhaps petrobonds over a set period of days at a
set interest rate. These transactions are known as report os. The
purchase of shares listed on the exchange is restricted by cor-
porate bylaws.
3.4 Borrowing from- abroad by residents.aliere-ar
Cs-jstr?TEtTi37?is on_Mexicans -borrowing al7c75-ErA loan must be
registered with the Treasury Department (Registrar of Debt) and
on the company's debt register. If the loan is not registered, the
company will be barred from obtaining access to controlled-rate
dollars at time of repayment. Unless they are strong exporters,
few Mexican firms can obtain foreign credit at present. There is a
FFO MEXICO C) January 1988 Business International Corp 7
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-rwErmiev-,,Ifsa
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15% withholding tax on interest paid on foreign bank loans.
Public sector firms, including mixed-capital companies with
minority government equity, are subject to tight controls on
foreign borrowings. Supervision has become even more
rigorous since the introduction of the Public Sector Debt Law,
which requires that quarterly statements of the public sector
debt position be submitted for congressional review. This watch-
dog mechanism is also meant to curb wasteful spending, since
the purpose of proposed borrowings must be justified.
3.5 Borrowing from abroad by nonresidents. The regula-
tions regarding external borrowing apply equally to domestic
and to foreign firms (see 3.4).
3.6 Local borrowing by nonresidents. Theoretically,
foreign companies and local firms have equal access to local
bank credit. In practice, however, banks do sometimes
discriminate against foreign companies in favor of local firms.
This tendency is partially offset by the superior credit ratings en-
joyed by MNCs.
3.7 Restrictions on export proceeds. Exporters must fill
out a foreign exchange sales pledge (CVD) obliging them to sell
receipts from foreign sales to their local commercial banks
within 90 days. Related imports, suppliers credits and export ex-
penses may be deducted. Secofi has streamlined the process for
obtaining approval for deductions of such related expenses. If
the original authorization for related expenses was based on
100% of f.o.b., a firm may exceed the authorized amount by
$500 dollars without seeking further approval. If the authorized
amount was based on 50% of f.o.b., the firm may exceed it by
$1,000 without further approval. Documentation proving the
additional expenses were incurred must be presented to the
bank handling the controlled dollar transaction. Officials apply
steep penalities for infringements?up to three times the amount
of illegally handled dollar funds. The same penalties apply to
underinvoicing of exports and overinvoicing of imports.
3.8 Restrictions on import payments. Some 90% of all
imports can be brought into Mexico without a license. All im-
ports are eligible for controlled-rate dollars, and availability is
currently unimpeded. But this could well change by mid-1988
with the increasing pressure on the peso.
Specific export requirements exist for certain industries. For
example, the automotive sector must balance their hard curren-
cy expenditures on imports with exports. On a less rigid basis,
foreign companies operating in the computer sector are ex-
pected to be able to cover their foreign exchange needs with ex-
ports. There is increasing pressure from the United States for
Mexico to drop these export requirements. Mexico's entry into
the General Agreement on Tariffs and Trade (GATT) also re-
quires it to phase out discriminatory practices by 1990, which is
likely to lead to changes in this area.
3.9 Repatriation of capital. Since exchange controls were
relaxed there have been no legal restrictions on the repatriation
of capital. Massive capital flight, however, would probably spark
renewed control.
3.10 Remittance of dividends and profits. Profits are
freely remittable, provided a company is registered with the Na-
tional Registry of Foreign Investment and meets legal reserve re-
quirements and tax obligations. By law, firms must distribute
8 FFO MEXICO @ January 1988 Business International Corp
10% of their pretax profits to employees and allocate 5% of net
profits to the legal reserve until 20% of stated capital has been set
aside.
A 1987 tax change lowered the withholding tax on dividends
from 55% to 50% (except for dividends reinvested within 30
days) but made the dividend paid deductible from taxable in-
come. A 1984 amendment of the tax law stipulates that
dividends paid out of one fiscal year's earnings may not be
deducted from that same fiscal year's taxable earnings. (In other
words, the dividend is still deductible, but not until the next
fiscal year.) A planned moved to a creditable dividend was to
have been implemented as of Jan. 1, 1986, but Mexico's recent
tax reforms halted the planned change and the dividends remain
deductible.
As of Jan. 1, 1985, firms have not been permitted to deduct
dividends generated by gains resulting from a revaluation of
assets. Companies that register losses while paying out dividends
must adjust their final results by the amount of the payout. Taxes
due on dividends must be withheld by the payor, including
payments to individuals. Earnings from dividends are included in
a company's taxable income. Dividends may be paid out of cur-
rent profits plus retained earnings. If a company has accrued
losses, dividends may be paid out of current profits alone.
3.11 Remittance of interest and principal on foreign
loans. Foreign exchange is available in the controlled market for
repayment (including interest, principal and related charges) on
foreign currency loans incurred after Dec. 20, 1982, and for
repayment of pre-Dec. 20, 1982, debt that has been properly
registered with the Secretariat of the Treasury and the Depart-
ment of Commerce and Industrial Development (Secofi).
Exporters may use their export proceeds to offset past-due sup-
plier debt. They may also use export revenues to make principal
and interest payments on registered foreign currency bank debt,
payable abroad and incurred after Dec. 20, 1982, provided
these obligations are not enrolled in the Ficorca private debt
coverage program. Interest payments on registered bank debt
incurred before Dec. 20, 1982, may also be made with export
revenues as long as the payments are not covered in the Ficorca
scheme. If Ficorca covers only part of the interest, exporters may
use their proceeds to pay the remainder up to the interest rate
stated in the debt register.
Firms may also purchase controlled dollars for import credits
incurred after Dec. 20, 1982, or deduct these payments from
their export revenues. However, payment of short-term import
credits cannot be made until 90 days after the shipment covered
by the credit arrives. A 10% advance payment may be made at
the controlled rate.
The average amortization period of a long-term credit must be
at least 12 months. An advance payment of 20% is allowed. Im-
porters can purchase controlled dollars for interest payments on
these credits up to the maximum yield of three-month deposits
in the corresponding foreign currency on the date interest is due;
the remainder must be covered with free-rate dollars.
Two payment mechanisms exist for supplier credits incurred
before Dec. 20, 1982, that are secured by the US Eximbank. In
both programs, debtors purchase dollars at the controlled rate
for the full amount of their obligation; companies then lend
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these dollars to tfie credit institution that will make payments
directly to Eximbank according to the amortization schedule.
The first program mainly covers long-term credits originally
due after Dec. 31, 1983, and follows the pattern of the debt
repayment/forward coverage scheme tied to a peso credit of the
1983 Ficorca program. The other program is administered by
Nafinsa, the government's development bank, and Bancomext,
which assume the credit risk. For this program, peso credits are
available as well and amortization payments fall due between
Dec. 31, 1984, and June 30, 1989, depending on the original
term of the loan. Exim bank decides which of the two schemes
may be used by the debtor company.
Ficorca continues to accept enrollments of new debt at the
Ficorca peso exchange rate at the time of approval of the trans-
action. With Ficorca approval companies can transfer their
Ficorca coverage to another company as well. Negotiations on
restructuring of the $11.2 billion private debt coverage
mechanism were completed in July 1987. Bankers rescheduled
the debt along the same terms Mexico received on its public
debt (20 years with seven years grace and an interest rate 13/16
of a percentage point above LIBOR.) Also included in the agree-
ment was a revolving fund system under which banks will be
able to relend peso payments in the domestic market. The
amount and rates to be charged on the relending will be con-
trolled by Banco de Mexico.
Bankers expect the peso onlending program to be operational
by the first quarter of 1988. They also predict that the govern-
ment will introduce a debt swap investment mechanism
whereby companies will be able to buy a bank's rights to the
pesos it receives through Ficorca at a discount in return for in-
vestment. Priority would probably be given to export projects,
relocations to priority zones and import-substitution.
However, the restructuring agreement of July 1987 means that
companies enrolled in Ficorca, except those under the supplier
credits program, will have to restructure their debt or prepay
their Ficorca obligations. Under the new scheme, debtors
choosing from eight-year terms with four years grace up to
12-year terms with six years grace will pay the same interest rate
as specified in the original April 1983 'agreement. This rate
equals the average of three- and six-month certificates of
deposit.
However, repayment will be based on the exchange rate on
the day the new contract is signed. Those entering into a con-
tract for more than the 12-year term will be allowed to choose
between these rescheduling terms, and maintaining the 1983 ex-
change rate with an interest rate equal to 110% of CPP (the
average monthly interest rate offered by banks on all accounts
except savings).
3.12 Remittance of royalties and fees. Payment of
royalties and fees covered by contracts that are approved and
registered can be made at the controlled exchange rate in force
on the day of the dollar purchase, provided that the contract
under which the fees are to be paid is duly registered with the
National Registry of Technology.Transfer. However, the free rate
is used to calculate the dollar equivalent of peso amounts. To
buy controlled dollars, firms must obtain a permit from the
Secretariat of Commerce General Office of Technology Transfer.
Companies are not allowed to use their export revenues to
cover royalties payments. The Secretariat of Commerce may
establish a payment schedule if none is stipulated in the con-
tract. Until recently, 3% of net sales was generally considered
the maximum royalty fee. However, the National Registry no
longer has firm guidelines on accepted royalty rates, and
authorities have permitted rates as high as 10% in certain in-
stances.
3.13 Hold accounts.
Foreign currency held locally by residents. Resident com-
panies may hold foreign-currency accounts in Mexico. The
minimum deposit is $5,000 and the dollars mot come from
abroad. Payments from these accounts can only be made
abroad.
Foreign currency held locally by nonresidents. These ac-
counts are generally not permitted, except for diplomatic mis-
sions and foreign correspondents, whose dollars must come
from abroad. Withdrawal can be made in pesos or US dollars.
Local currency held locally by nonresidents. Interest-bearing
time deposit and non-interest-bearing demand-deposit accounts
are allowed, but central bank permission is necessary for larger
accounts. Nonresident accounts may not be debited directly for
transfets abroad.
Foreign currency held abroad by residents. As of Sept. 1,
1982, residents are prohibited from opening foreign-currency
accounts abroad. In October 1987, the government passed
leglislation allowing residents living along the Mexican border
with the United States to hold dollar accounts in Mexican banks.
However, investors are wary since pre-debt crisis dollar ac-
counts held in Mexican banks were redeemed in pesos at less
than 50% of their value once the crisis hit in 1982. Meanwhile,
the Mexican authorities have urged residents holding outstand-
ing accounts abroad to transfer those funds to Mexico but have
not forced them to do so, and many Mexican nationals continue
to hold foreign savings and checking accounts.
3.14 Leading and lagging. Although Mexico places no
legal restrictions on leading and lagging of exports and imports,
exchange controls have effectively done away with these
mechanisms. Foreign suppliers require prompt payment on
delivery. Import licenses, when required, are valid for six
months and can be extended by three months in some cases.
There is increasing use of letters of credit.
3.15 Netting. Bilateral or multilateral netting between or
within companies is not permitted.
3.16 Other restrictions. N.a.
ea-The_Monetary.Siiren
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